A large section of people, particularly the salaried class’ debt is unavoidable. Here is how borrowing irresponsibly can land you in trouble.
As per ET Wealth survey, 15% of the respondents have an EMI outgo of more than half of their income.
The survey was conducted in March and had 2,042 respondents from throughout the country, age groups and income levels.
According to the survey, 32% of the respondents with EMIs of more than 50% of their income are senior citizen, who have fixed incomes.
The survey also showed that one out of five respondents have taken loans to repay other loans in the the past one year.
“Debt is not a bad thing. But you need to plan properly, so that you don’t get into a debt trap,” says Manav Jeet, MD and CEO, Rubique, an online marketplace for financial products.
Sudden events like a job loss, a medical emergency, etc. can force one to borrow beyond one’s repayment capacity, says Vinod N. Kulkarni, a financial counsellor.
“Salaries getting delayed has also become a major factor leading people into debt traps as they try to survive on credit cards,” says Arun Ramamurthy, Founder, Credit Sudhaar.
Taking a loan to repay another is a classic indicator of falling into a debt trap.
These sudden shocks can be avoided by maintaining a contingency reserve of around six months’ income and having insurance.
But it is often the slow, gradual slide into a debt trap that can prove more dangerous as it goes unnoticed till the person is neck deep in it. We point out the red flags, so you can take corrective measures, if need be.
1. EMIs exceeding 50% of income
A lot many people fall prey to ‘easy EMIs’, ‘discounts’, and ‘sales’. Compulsive spending can strain your finances and push you towards a debt trap.
“Some or the other sale will always be on and people who can’t control themselves often end up buying things on EMIs. Though these standalone EMIs may not be big, when you add the various EMI obligations, you may have little money left to spend on other things,” says Ranjit Punja, CEO, CreditMantri.
2. Fixed expenses more than 70% of income
Apart from EMI, there are several other fixed expenses like rent, society maintenance charges, kids’ school fee, etc. “Ideally, the fixed obligations-to-income ratio (FOIR) should not be more than 50%,” says Punja.
3. Loan for regular expenses
If you often find yourself borrowing money to meet regular expenses, you need to set your house in order. “If you have to borrow regularly to meet routine expenses like rent, children’s school fees, etc., you may be sliding into a debt trap,” says C.S. Sudheer, CEO and Founder, IndianMoney.
4. Loan to repay a loan
Borrowing money to repay a loan, unless it is aimed at reducing one’s interest outgo, as in the case of changing one’s home loan lender, is a worrying sign. Another worrying sign is the way people deal with their fixed obligations.
5. Withdrawing cash from credit card
While borrowing for regular expenses to repay loans is bad, doing that with the help of credit card is a sure way of getting oneself into trouble. “Even if you want to borrow, decide on the kind of debt. Using the credit card route should always be avoided,” says Manav Jeet, MD and CEO, Rubique, an online marketplace for financial products.
6. Not clearing credit card dues
Not clearing the credit card dues in full is a huge red flag. Our survey shows that this practice of not paying the credit card bill in full is quite rampant. Almost 21% of the respondents have either missed the credit card payment or rolled it over by paying the minimum due amount over the past year.
7. Banks refusing loan
ET survey reveals that banks have rejected loan applications of 5.4% of the respondents.
“Banks rejecting your loan application is a dangerous sign, especially, if it is done because of the fall in your credit score,” says C.S. Sudheer, CEO and Founder, IndianMoney.
Though the credit score ranges from 300 to 900, only scores above 750 are considered good by most banks.
8. Missed utility bill payments
Missing utility bills once in a while is not a warning sign. However, if you are frequently missing paying utility bills, you maybe spending beyond your means, and it’s a red flag. It also indicates lack of financial literacy—the fact that this will impact your credit score and may keep you away from lowcost funding options.
9. Borrowing based on future income
If you decide to take a loan now and aim to repay it when you get a fancy bonus later this year, you may be in for trouble. “People always hope for the best and don’t factor in possible problems that may emerge in the future. So, borrowing based on current salary is fine, but not on expected bonus, increments, etc,” warns Jeet.
10. Loans with rising EMIs
Many people tend to overestimate the future salary increments. Since the base is small, increments are higher at the start of one’s career. So, assuming that you will get the similar increments till you retire to take larger loans may not be a prudent strategy. Banks also encourage such unhealthy habits by offering loan products where the EMIs increase with time, usually after a gap of a few years.
11. Buying gadgets on ‘easy EMIs’
Several people tend to be impulsive shoppers, and even end up buying non-essential items on loans. Loans from financial institutions come with ‘easy EMIs’ and many of the NBFCs are now located within the shopping complexes selling consumer durables, making it easier for consumers to borrow. But though these loans are floated with features like ‘easy EMIs’, they come with high interest rates 18-25%.
By: Abhinav Ranjan, Editorial Desk, DKODING Media